The Problem of Corruption

The Free Market 20, no. 6 (June 2002)

Corruption breeds poverty. That is the conclusion of the latest World Development Report, in which the World Bank cites "evidence that higher levels of corruption are associated with lower per capita income" (World Bank, 2002). The story told is that bribes raise the costs of doing business, so more corrupt countries attract less foreign direct investment, which lowers growth rates and per capita incomes.

However, this masks an important distinction between Business-to-Business (B2B) and Business-to-Government (B2G) bribery. The former is often best ignored since it is either beneficial or self-correcting. The latter merits widespread public attention.

In its mildest and most benign form, B2B bribery can facilitate communication (reduce information costs) and help cement relationships between principals (say in a supply chain). "Facilitation payments" (anything from generous commissions, to golf club memberships and free meals and entertainment) can replace costly contingent contracts with implicit contracts that ensure quality, quantity, and schedule requirements are met. In this case B2B bribery has an offsetting benefit that on net lowers transaction costs and greases the wheels of commerce.

Bad cases of B2B bribery typically involve a private gain by an employee with no offsetting benefits. This more insidious form is like a worm that eats into corporate profits. For instance, if, as alleged, Enron insiders made subtle side payments (steering business) to partners like Arthur Andersen to promote/conceal fraudulent financing and accounting activities, then shareholders are the victims.

If revealed soon enough, internal corruption involves costs that shareholders should be happy to shed, along with its perpetrators. If revealed too late (or if corruption is endemic), bankruptcy is the outcome. Because of this automatic regulation of B2B bribery, and the fact that some is beneficial, governments should generally limit their interference to encouraging transparency. Here the shorter the arm of the law the better, since markets should take care of the rest.

In sharp contrast, bad cases of B2G bribery involve private gains (usually by corporations and public employees) at the expense of competing companies and the general public. The big difference between B2B and B2G bribery is the "G"—Government. Government officials have the power to change the rules of the game. More important than their role in providing monopoly services and letting government contracts, public officials control the very institutions that govern market activity.

Not surprisingly, a popular form of B2G bribery involves "rent-seeking" to influence the design or enforcement of rules, regulations, tax assessments, zoning, contracts, etc. Unfortunately, as Mises emphasizes in Human Action (3rd ed.), in the case of B2G corruption, "as a rule, one individual or a group of individuals is enriched at the expense of other individuals or groups of individuals." In contrast to some B2B bribery that can actually benefit both parties, B2G bribery is at best a zero-sum game.

When a company or industry attempts to gain competitive advantage through B2G bribery, this triggers other industries and consumer groups to defend themselves. Even in cases where a business might bribe officials to bypass truly bad regulations, this triggers counter-lobbying by companies that benefit from these regulations. Sometimes these regulations are nothing more than thinly veiled barriers to protect incumbent (domestic) firms from (foreign) competition. As GordonTullock and others have demonstrated, the sum of resources exhausted in offensive and defensive B2G bribery can be far greater than the value of the favorable ruling or government contract.

Instead of merely redistributing the pie—a zero-sum game (what I win, you lose)—in this case, B2G bribery shrinks the pie—a negative-sum game (we all lose). Of course, in its mildest and most benign form B2G activity is known as legal lobbying. However, in its more nefarious manifestations, this activity can take covert forms such as "offset agreements"—sponsoring an unrelated "social project" that benefits public officials or their friends and relatives in return for a government (defense) contract; "revolving doors"—promises of lucrative positions within the company; and payments to offshore bank accounts.

Less government equals less corruption. Companies will always seek government favors. Mises reminds us "corruption is a regular event of interventionism" (Human Action, 3rd ed.). Therefore, the fewer rules, regulations, contracts, etc., government officials have the discretion to write, modify, or enforce, the less opportunity for corruption. The more transparent their actions and the more they have to lose, the better. Encouraging governments to employ fewer public servants with less power and more pay is a step in the right direction. However, targeting the right worm is also crucial.

Promoting transparency is bad for both worms (B2B and B2G), and is the key to minimizing corruption. But whereas the short arm of the law is sufficient to deal with B2B bribery, it is incumbent upon citizens in every country to curb the power of government and demand transparency of their public officials.

Overly complex regulations are especially problematic. For instance, the World Bank reports that to start a business in Mozambique takes nineteen steps, five months, and a year's worth of income, while in Australia it takes only two steps, two days, and 2 percent of income (World Development Report 2002). Instead of protecting consumers and businesses, out-of-control government regulations crush market activity and act as a breeding ground for corruption.

The strategy taken by the 1998 OECD anticorruption treaty, which threatens to penalize multinational corporations that supply B2G bribes, is not the answer. It simply invites more creative techniques by companies to influence government decisions. Reducing the power of public officials and addressing their incentives to demand bribes is a more effective solution. The world's free press, nonprofit government organizations like Transparency International, and multinational institutions like the OECD, IMF, and World Bank, can play supporting roles. The risk is that international institutions like the IMF and World Bank inadvertently contribute to corruption through well-intentioned efforts to deal with shaky governments.

Tackling the B2G worm in the poorest countries is especially urgent. Since a reduction in corruption is associated with a reduction in poverty, helping today's poor countries streamline their governments and make those governments more open and accountable is one way to ensure their children will be better off.